Insurance Overlays and Retirement Asset Allocation

“Insurance Overlays and Retirement Spending” discusses how an insurance overlay can help investors increase their retirement spending while retaining control of their assets, including how their assets are allocated. A key feature of the overlay is the tight link between portfolio performance and the income that can be withdrawn.

But this raises an important question: How can investors and their advisors go about choosing an asset allocation that strikes the desired balance between the variability and potential growth of retirement income?

As a reminder, the initial income available for withdrawals is equal to a fixed percentage (e.g., 4% or 5%) of assets, set by the insurance company, at the beginning of retirement. The available income then evolves as follows.

1. Until the account is depleted, the income evolves according to portfolio returns. If the net return on the portfolio is 10%, the available income goes up by 10%.
   
   
2. When the account is depleted, the nominal income level freezes in place. The insurance overlay pays that income annually, for life.

Exhibit 1 follows the evolution of income in nominal (Panel A) and real (Panel B) terms using returns from the last 35 years for fixed income, 60% stock/40% bond, and equity allocations. The hypothetical investor retires at age 65 in 1989. Until account depletion, which occurs in 2012 at age 88 (vertical line in both panels of Exhibit 1), the benefit base and income move with portfolio returns. The 60/40 and equity allocations experience rapid growth, but also sharp drawdowns during the dot-com downturn and the Global Financial Crisis (GFC). After account depletion, the insurance overlay pays, for life, the last recorded income value. Since the income is fixed in nominal terms (as shown in Panel A), its inflation-adjusted value (Panel B) gradually decreases over time.

While Exhibit 1 is only one example, it helps to illustrate the main tradeoff: Riskier allocations experience higher volatility but typically lead to higher income overall, including the lifetime income paid by the overlay. To get a sense of what outcomes could be under different environments, we examine the distributions of the annual changes in real income prior to account depletion as well as the lifetime income paid by the overlay at account depletion.

Exhibit 2 shows, for different asset allocations, the distribution of annual changes in real income based on 10,000 bootstrapped samples of historical returns from 1989 to 2024. As equity exposure increases, the range of outcomes widens steadily as expected: The spread between the 10th percentile and the 90th percentile increases from fewer than 10 percentage points for the fixed income portfolio to almost 40 percentage points for the equity portfolio. Even a diversified 60/40 portfolio can experience sharp fluctuations: In the best 10% of simulated years, income grows by more than 16%, while it decreases by more than 9% in the worst 10% of the years. Therefore, investors who rely on an insurance overlay for a large part of their spending may wish to maintain some exposure to fixed income in order to stabilize income.

The accumulation of these year-over-year changes determines the lifetime income that the insurance overlay will ultimately pay if the investor outlives their assets. Exhibit 3 sheds light on this by plotting percentiles of real lifetime income levels at account depletion. The results are based on 10,000 bootstrapped samples, where each bootstrap sample tracks the evolution of income from retirement to account depletion, when the overlay kicks in, assuming a 4.25% income rate on the benefit base. With a 4.25% income rate, the account is depleted 23 years after the beginning of retirement.

While the final income is more uncertain for riskier portfolios, it is likely to be substantially higher than for more conservative allocations. For instance, with a 60/40 allocation, the final income has a 50% chance of essentially tripling relative to the initial income, even after adjusting for inflation—$119,244 versus $42,500. The median final income with an all-bond allocation is $49,087, only 15% higher than the initial income. Therefore, investors who wish to plan for late-life consumption (e.g., long-term care) may wish to take on at least some investment risk in order to increase the odds of ultimately securing a higher lifetime income. We also note that asset allocation need not be static. In particular, investors can rebalance toward a more conservative asset allocation over time as they progress toward their income goals.

So far, we have focused on the entire income prescribed by the insurance overlay every year. However, as we discussed in an earlier blog post, investors also have the option of “banking” income for future use by withdrawing less. For example, in Exhibit 1, an investor could have banked additional income early on and used the excess to partially offset the decline in spending during the market crashes. Our research paper provides more details. However, we note that poor returns can also occur right after retirement, before any income is banked, or that sharply negative returns could eventually deplete banked income reserves. Therefore, investors should not see the possibility of banking income as a license to take undue risk with their asset allocation, but rather as an extra tool to help smooth fluctuations.

In summary, by controlling the underlying asset allocation, investors and their advisors can build retirement income streams that match their preferences for variability and growth potential. Investors who rely on the insurance overlay income to cover most of their spending may wish to consider a more conservative asset allocation in order to limit annual fluctuations. Others who either have more tolerance for annual fluctuations or put greater weight on the probability of achieving a higher income trajectory may consider increasing their allocation to equities to emphasize growth potential. In addition, regardless of the split between equities and fixed income, a broadly diversified, well-implemented asset allocation can help manage fluctuations and increase expected income growth.

Weights as of December 31, 2024, the end of the sample period. Rebalanced monthly. Totals may not equal 100% due to rounding. For illustrative purposes only. The Dimensional Index Allocations are unmanaged and are not subject to fees and expenses typically associated with managed accounts or investment funds. Indices are not available for direct investment. Past performance is no guarantee of future results.

The Dimensional indices used in the construction of the Index Allocations represent academic concepts that may be used in portfolio construction. The Index Allocations and the indices are not available for direct investment or for use as a benchmark. Their performance does not reflect the expenses associated with the management of an actual portfolio. The Index Allocations and index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. See “Sources and Descriptions of Data” for additional information, including descriptions of the Dimensional index data.

Dimensional US Core Equity 1 Index
January 1975–present

Compiled by Dimensional from CRSP and Compustat data. Targets all the securities in the eligible market with an emphasis on companies with smaller capitalization, lower relative price, and higher profitability, excluding those with the lowest profitability and highest relative price within the small cap universe. The index also excludes those companies with the highest asset growth within the small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. The eligible market is composed of securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market. Exclusions: non‑US companies, REITs, UITs, and investment companies. The index has been retrospectively calculated by Dimensional and did not exist prior to March 2007. Accordingly, the results shown during the periods prior to March 2007 do not represent actual returns of the index. Other periods selected may have different results, including losses. The calculation methodology for the index was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. The calculation methodology for the index was amended in December 2019 to include asset growth as a factor in selecting securities for inclusion in the index.

Prior to January 1975

Compiled by Dimensional from CRSP and Compustat data. Targets all the securities in the eligible market with an emphasis on companies with smaller capitalization and lower relative price. The eligible market is composed of securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market. Exclusions: non‑US companies, REITs, UITs, and investment companies.

Dimensional US Core Equity 2 Index
January 1975–present

Compiled by Dimensional from CRSP and Compustat data. Targets all the securities in the eligible market with an emphasis on companies with smaller capitalization, lower relative price, and higher profitability, excluding those with the lowest profitability and highest relative price within the small cap universe. The index also excludes those companies with the highest asset growth within the small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. The eligible market is composed of securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market. Exclusions: non‑US companies, REITs, UITs, and investment companies. The index has been retrospectively calculated by Dimensional and did not exist prior to March 2007. Accordingly, the results shown during the periods prior to March 2007 do not represent actual returns of the index. Other periods selected may have different results, including losses. The calculation methodology for the index was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. The calculation methodology for the index was amended in December 2019 to include asset growth as a factor in selecting securities for inclusion in the index.

Prior to January 1975

Compiled by Dimensional from CRSP and Compustat data. Targets all the securities in the eligible market with an emphasis on companies with smaller capitalization and lower relative price. The eligible market is composed of securities of US companies traded on the NYSE, NYSE MKT (formerly AMEX), and Nasdaq Global Market. Exclusions: non‑US companies, REITs, UITs, and investment companies.

Dimensional International Core Equity 2 Index

Compiled by Dimensional from Bloomberg securities data. Targets all the securities in the eligible markets with an emphasis on companies with smaller capitalization, lower relative price, and higher profitability, excluding those with the lowest profitability and highest relative price within their country’s small cap universe. The index also excludes those companies with the highest asset growth within their country’s small cap universe. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. Asset growth is defined as change in total assets from the prior fiscal year to current fiscal year. The index monthly returns are computed as the simple average of the monthly returns of four subindices, each one reconstituted once a year at the end of each quarter of the year. Maximum index weight of any one company is capped at 5%. Countries currently included are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the UK. Exclusions: REITs and investment companies. The index has been retrospectively calculated by Dimensional and did not exist prior to April 2008. Accordingly, the results shown during the periods prior to April 2008 do not represent actual returns of the index. The calculation methodology for the index was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. The calculation methodology for the index was amended in November 2019 to include asset growth as a factor in selecting securities for inclusion in the index.

Dimensional Emerging Markets Core Equity 2 Index

Compiled by Dimensional from Bloomberg securities data. Targets large cap securities in the eligible markets with an emphasis on companies with smaller capitalization, lower relative price, and higher profitability. Profitability is defined as operating income before depreciation and amortization minus interest expense divided by book equity. The index monthly returns are computed as the simple average of the monthly returns of four subindices, each one reconstituted once a year at the end of each quarter of the year. Maximum index weight of any one company is capped at 5%. Countries currently included are Brazil, Chile, China, Colombia, the Czech Republic, Greece, Hungary, India, Indonesia, Kuwait, Malaysia, Mexico, Peru, the Philippines, Poland, Qatar, Saudi Arabia, South Africa, South Korea, Taiwan, Thailand, Turkey, and the UAE. Exclusions: REITs and investment companies. The index has been retrospectively calculated by Dimensional and did not exist prior to April 2008. Accordingly, the results shown during the periods prior to April 2008 do not represent actual returns of the index. The calculation methodology for the index was amended in January 2014 to include profitability as a factor in selecting securities for inclusion in the index. The calculation methodology for the index was amended in November 2019 to include asset growth as a factor in selecting securities for inclusion in the index.

S&P Global REIT Index

Shown gross of dividend withholding tax. S&P data © 2025 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.

Bloomberg US TIPS Index

Bloomberg data provided by Bloomberg. 

Dimensional Short-Term Extended Quality Index

Compiled by Dimensional using data provided by Bloomberg. Includes securities in Bloomberg US 3–5 Year Government, Credit Aaa, Aa, A, Baa indices, and Bloomberg US 1–3 Year Government, Credit Aaa, Aa, A, Baa indices. Securities can be over- or underweighted based on government/credit spreads. When the difference in yields between credit and government bonds is narrow, government bonds may be overweighted. When the difference in yields between credit and government bonds is wide, government bonds may be underweighted. Securities can be over- or underweighted with respect to their market cap weight based on credit spreads. When the difference in yields between AAA+AA and A+BBB is narrow, AAA+AA bonds may be held above market cap weight. When the difference in yields between AAA+AA and A+BBB is wide, AAA+AA bonds may be held below market cap weight. When the difference in yields between AAA+AA and BBB is narrow, BBB bonds may be held below market cap weight. When the difference in yields between AAA+AA and BBB is wide, BBB bonds may be held above market cap weight. The duration of the index is based on the term spread between the 3–5 year government/credit bonds and 1–3 year government/credit bonds. When the term spread is wide, the duration of the index can be longer than the duration of the Bloomberg US Credit 1–5 Year Index. When the term spread is narrow, the duration of the index can be shorter than the duration of the Bloomberg US Credit 1–5 Year Index. The duration of the government component is based on the term spread between 3–5 year government bonds and 1–3 year government bonds. When the term spread is wide, the duration of the index can be longer than the duration of the Bloomberg US Government 1–5 Year Index. When the term spread is narrow, the duration of the index can be shorter than the duration of the Bloomberg US Government 1–5 Year Index. Rebalanced monthly. The index has been retrospectively calculated by Dimensional and did not exist prior to January 2020. Accordingly, results shown during the periods prior to January 2020 do not represent actual returns of the index. Other periods selected may have different results, including losses.

Dimensional US Core Fixed Income Index

Compiled by Dimensional using data provided by Bloomberg. Includes securities in the Bloomberg US 5–10Y Government, Credit Aaa, Aa, A, Baa indices; Bloomberg US 1–5Y Government, Credit Aaa, Aa, A, Baa indices; and Bloomberg Remix Portfolio (TBA Proxy) Index. Securities can be over- or underweighted based on government/credit spreads. When the difference in yields between credit and government bonds is narrow, government bonds may be held above 50%. When the difference in yields between credit and government bonds is wide, government bonds may be held below 50%. Securities can be over- or underweighted with respect to their market cap weight based on credit spreads. When the difference in yields between AAA+AA and A+BBB is narrow, AAA+AA bonds may be held above market cap weight. When the difference in yields between AAA+AA and A+BBB is wide, AAA+AA bonds may be held below market cap weight. When the difference in yields between AAA+AA and BBB is wide, BBB bonds may be held above market cap weight. The duration of the index is based on the duration of its government/credit component and the duration of the Bloomberg Remix Portfolio (TBA Proxy) Index. The duration of the government/credit component of the index is based on the term spread between 5–10 year government/credit bonds and 1–5 year government/credit bonds. When the term spread is wide, the duration of the government/credit component can be slightly shorter than the duration of the Bloomberg US Aggregate Bond Index. When the term spread is narrow, the duration of the government/credit component can be moderately shorter than the duration of the Bloomberg US Aggregate Bond Index. The duration of the government component is based on the term spread between 5–10 year government bonds and 1–5 year government bonds. When the term spread is wide, the duration of the government component can be slightly shorter than the duration of the Bloomberg US Government Index. When the term spread is narrow, the duration of the index can be moderately shorter than the duration of the Bloomberg US Government Index. The index’s backtested performance is based on the performance of the government/credit component, the Bloomberg Remix Portfolio (TBA Proxy) Index, and the ICE 1M USD LIBOR Index. Rebalanced monthly. The index has been retrospectively calculated by Dimensional and did not exist prior to December 2021. Accordingly, results shown during the periods prior to December 2021 do not represent actual returns of the index. Other periods selected may have different results, including losses. Data includes composite data from multiple sources or custom blends.

Dimensional Global ex US Core Fixed Income Index (Hedged to USD)

Compiled by Dimensional using data provided by Bloomberg. Based on securities in the universe of the Bloomberg Global Aggregate Bond Index; includes global government bonds and global investment grade corporate bonds. Eligible currencies: AUD, CAD, CHF, EUR, GBP, and JPY. Within the universe, the index identifies the yield curves that offer higher expected returns and the duration ranges on those yield curves offering higher expected returns, and assesses the increased expected returns associated with allocation to bonds with different credit qualities. It then overweights (with respect to their market cap weight) bonds of yield curves, duration ranges, and credit qualities that offer higher expected returns. It also employs credit quality, currency, and duration requirements relative to the eligible market. Rebalanced monthly. The index has been retrospectively calculated by Dimensional and did not exist prior to October 2023. Accordingly, results shown during the periods prior to October 2023 do not represent actual returns of the index. Other periods selected may have different results, including losses.

Dimensional Global Credit Bond Index (Hedged to USD)

Compiled by Dimensional using data provided by Bloomberg. Based on securities in the universe of the Bloomberg Global Aggregate Bond Index and includes global investment grade corporate bonds, global supranational bonds, global sovereign bonds, global foreign agency bonds, global foreign local authorities bonds, and US local authorities bonds. Eligible currencies: AUD, CAD, CHF, EUR, GBP, JPY, and USD. Within the universe, the index identifies the yield curves that offer higher expected returns and the duration ranges on those yield curves offering higher expected returns, and assesses the increased expected returns associated with allocation to bonds with different credit qualities. It then overweights (with respect to their market cap weight) bonds of yield curves, duration ranges, and credit qualities that offer higher expected returns. It also employs credit quality, currency, and duration requirements relative to the eligible market. Rebalanced monthly. The index has been retrospectively calculated by Dimensional and did not exist prior to October 2023. Accordingly, results shown during the periods prior to October 2023 do not represent actual returns of the index. Other periods selected may have different results, including losses.